INNOVATE Corp. - FORM 10-Q - November 9, 2016

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EX-32 - EXHIBIT 32 - INNOVATE Corp.a2016-q3form10xqexhibit32.htm
EX-31.2 - EXHIBIT 31.2 - INNOVATE Corp.a2016-q3form10xqexhibit312.htm
EX-31.1 - EXHIBIT 31.1 - INNOVATE Corp.a2016-q3form10xqexhibit311.htm
EX-10.5 - EXHIBIT 10.5 - INNOVATE Corp.a10_5hc2-preferredconversi.htm
EX-10.4 - EXHIBIT 10.4 - INNOVATE Corp.a10_4hc2-preferredconversi.htm
EX-10.3 - EXHIBIT 10.3 - INNOVATE Corp.a10_3hc2-preferredconversi.htm
EX-10.2 - EXHIBIT 10.2 - INNOVATE Corp.a10_2hc2-preferredconversi.htm
EX-10.1 - EXHIBIT 10.1 - INNOVATE Corp.a10_1indemnificationagreem.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________________________________________________________________________________
FORM 10-Q
_________________________________________________________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

Commission File No. 001-35210 
_________________________________________________________________________________________
HC2 HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
_________________________________________________________________________________________
Delaware
 
54-1708481
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
450 Park Avenue, 30th Floor
 
 
New York, NY
 
10022
(Address of principal executive offices)
 
(Zip Code)
 
 (212) 235-2690
(Registrant’s telephone number, including area code)
______________________________________________________________

______________________________________________________________

Former name or former address, if changed since last report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer
¨
Accelerated filer
x
 
 
 
 
Non-accelerated filer
¨
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding as of October 31, 2016
Common Stock, $0.001 par value
41,818,944
 



HC2 HOLDINGS, INC.
INDEX TO FORM 10-Q

PART I. FINANCIAL INFORMATION
 
 3
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
 
 
 
 

2

HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)


PART I: FINANCIAL INFORMATION

Item 1. Financial Statements



Three Months Ended September 30,

Nine Months Ended September 30,
 

2016

2015

2016

2015
Services revenue

$
245,064


$
151,933


$
624,545


$
373,492

Sales revenue

133,474


125,534


379,729


386,765

Life, accident and health earned premiums, net

19,967


—


59,939


—

Net investment income

14,799


—


42,585


—

Net realized losses on investments

(220
)

—


(2,677
)

—

Net revenue

413,084


277,467


1,104,121


760,257

Operating expenses








Cost of revenue - services

225,876


138,099


583,942


334,608

Cost of revenue - sales

107,984


102,395


308,951


324,820

Policy benefits, changes in reserves, and commissions

29,689


—


92,784


—

Selling, general and administrative

36,902


28,810


107,493


77,818

Depreciation and amortization

5,961


6,267


18,163


17,768

Gain on sale or disposal of assets

(23
)

(1,106
)

(973
)

(135
)
Lease termination costs

(159
)

1,124


179


1,124

Total operating expenses

406,230


275,589


1,110,539


756,003

Income (loss) from operations

6,854


1,878


(6,418
)

4,254

Interest expense

(10,719
)

(10,383
)

(31,614
)

(29,208
)
Other income (expense), net

(3,203
)

1,193


(4,220
)

(1,378
)
Income from equity investees

335


918


3,153


427

Loss from continuing operations before income taxes

(6,733
)

(6,394
)

(39,099
)

(25,905
)
Income tax benefit (expense)

1,334


(1,504
)

3,649


1,832

Loss from continuing operations

(5,399
)

(7,898
)

(35,450
)

(24,073
)
Loss from discontinued operations

—


(24
)

—


(44
)
Net loss

(5,399
)

(7,922
)

(35,450
)

(24,117
)
Less: Net (income) loss attributable to noncontrolling interest and redeemable noncontrolling interest

841


(65
)

2,365


(8
)
Net loss attributable to HC2 Holdings, Inc.

(4,558
)

(7,987
)

(33,085
)

(24,125
)
Less: Preferred stock and deemed dividends

2,948


1,035


5,061


3,212

Net loss attributable to common stock and participating preferred stockholders

$
(7,506
)

$
(9,022
)

$
(38,146
)

$
(27,337
)
Basic loss per common share:








Loss from continuing operations

$
(0.20
)

$
(0.35
)

$
(1.07
)

$
(1.09
)
Loss from discontinued operations

—


—


—


—

Basic and diluted loss per common share

$
(0.20
)

$
(0.35
)

$
(1.07
)

$
(1.09
)
Diluted loss per common share:








Loss from continuing operations

$
(0.20
)

$
(0.35
)

$
(1.07
)

$
(1.09
)
Loss from discontinued operations

—


—


—


—

Net loss attributable to common stock and participating preferred stockholders

$
(0.20
)

$
(0.35
)

$
(1.07
)

$
(1.09
)
Weighted average common shares outstanding:








Basic

36,627


25,592


35,808


25,093

Diluted

36,627


25,592


35,808


25,093

See accompanying notes to Condensed Consolidated Financial Statements.

3

HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(Unaudited)



 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Net loss
 
$
(5,399
)
 
$
(7,922
)
 
$
(35,450
)
 
$
(24,117
)
Other comprehensive income (loss)
 
 

 
 

 
 

 
 

Foreign currency translation adjustment
 
672

 
(5,275
)
 
1,335

 
(7,147
)
Unrealized gain (loss) on available-for-sale securities, net of tax
 
8,972

 
(2,008
)
 
71,261

 
(4,186
)
Less: Comprehensive (income) loss attributable to the noncontrolling interest and redeemable noncontrolling interest
 
841

 
(65
)
 
2,365

 
(8
)
Comprehensive income (loss) attributable to HC2 Holdings, Inc.
 
$
5,086

 
$
(15,270
)
 
$
39,511

 
$
(35,458
)

See accompanying notes to Condensed Consolidated Financial Statements.


4

HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
(Unaudited)




September 30, 2016

December 31, 2015
Assets




Investments:




Fixed maturity securities, available-for-sale at fair value

$
1,331,677


$
1,231,841

Equity securities, available-for-sale at fair value

56,506


49,682

Mortgage loans

8,939


1,252

Policy loans

18,228


18,476

Other invested assets

60,870


53,119

Total investments

1,476,220


1,354,370

Cash and cash equivalents

121,321


158,624

Restricted cash

791


538

Accounts receivable (net of allowance for doubtful accounts of $3,033 and $794 at September 30, 2016 and December 31, 2015, respectively)

272,738


210,853

Costs and recognized earnings in excess of billings on uncompleted contracts

17,091


39,310

Inventory

8,973


12,120

Recoverable from reinsurers

525,599


522,562

Accrued investment income

15,751


15,300

Deferred tax asset

43,555


52,511

Property, plant and equipment, net

244,176


214,466

Goodwill

86,025


61,178

Intangibles, net

39,144


29,409

Other assets

35,520


65,206

Assets held for sale

1,093


6,065

Total assets

$
2,887,997


$
2,742,512

Liabilities, temporary equity and stockholders’ equity




Life, accident and health reserves

$
1,637,501


$
1,591,937

Annuity reserves

254,250


260,853

Value of business acquired

48,512


50,761

Accounts payable and other current liabilities

232,149


225,389

Billings in excess of costs and recognized earnings on uncompleted contracts

51,241


21,201

Deferred tax liability

12,807


4,281

Long-term obligations

396,688


371,876

Pension liability

20,744


25,156

Other liabilities

12,042


17,793

Total liabilities

2,665,934


2,569,247

Commitments and contingencies




Temporary equity:




Preferred stock, $.001 par value - 20,000,000 shares authorized; Series A - 27,308 and 29,172 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively; Series A-1 - 1,000 and 10,000 shares issued and outstanding at September 30, 2016 and December 31, 2015; Series A-2 - 14,000 shares issued and outstanding at September 30, 2016 and December 31, 2015

41,659


52,619

Redeemable noncontrolling interest

1,993


3,122

Total temporary equity

43,652


55,741

Stockholders’ equity:




Common stock, $.001 par value - 80,000,000 shares authorized; 38,263,606 and 35,281,375 shares issued and 38,031,325 and 35,249,749 shares outstanding at September 30, 2016 and December 31, 2015, respectively

38


35

Additional paid-in capital

228,842


209,477

Accumulated deficit

(112,814
)

(79,729
)
Treasury stock, at cost

(1,262
)

(378
)
Accumulated other comprehensive gain (loss)

37,221


(35,375
)
Total HC2 Holdings, Inc. stockholders’ equity before noncontrolling interest

152,025


94,030

Noncontrolling interest

26,386


23,494

Total stockholders’ equity

178,411


117,524

Total liabilities, temporary equity and stockholders’ equity

$
2,887,997


$
2,742,512

See accompanying notes to Condensed Consolidated Financial Statements.

5

HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(in thousands)
(Unaudited)


 
 
Common Stock
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income (Loss)
 
Non- controlling Interest
 
 
 
 
Shares
 
Amount
 
 
 
 
 
 
Total
Balance as of December 31, 2014
 
23,813

 
$
24

 
$
141,948

 
$
(378
)
 
$
(44,164
)
 
$
(18,243
)
 
$
25,208

 
$
104,395

Share-based compensation expense
 
—

 
—

 
7,402

 
—

 
—

 
—

 
—

 
7,402

Dividend paid to noncontrolling interest
 
—

 
—

 
—

 
—

 
—

 
—

 
(1,038
)
 
(1,038
)
Preferred stock dividends and accretion
 
—

 
—

 
(3,212
)
 
—

 
—

 
—

 
—

 
(3,212
)
Amortization of issuance costs and beneficial conversion feature
 
—


—


(375
)

—


—


—


—


(375
)
Issuance of Common Stock
 
5

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Issuance of restricted stock
 
1,539

 
2

 
—

 
—

 
—

 
—

 
—

 
2

Conversion of Preferred Stock
 
235

 
—

 
1,000

 
—

 
—

 
—

 
—

 
1,000

Acquisition of controlling interest
 
—

 
—

 
—

 
—

 
—

 
—

 
(822
)
 
(822
)
Excess book value over fair value of purchased noncontrolling interest
 
—

 
—

 
43

 
—

 
—

 
—

 
(43
)
 
—

Excess of fair value of net assets over purchase price of acquired company
 
—

 
—

 
182

 
—

 
—

 
—

 
—

 
182

Net loss
 
—

 
—

 
—

 
—

 
(24,125
)
 
—

 
8

 
(24,117
)
Foreign currency translation adjustment
 
—

 
—

 
—

 
—

 
—

 
(7,147
)
 
—

 
(7,147
)
Unrealized loss on available-for-sale securities, net of tax
 
—

 
—

 
—

 
—

 
—

 
(4,186
)
 
—

 
(4,186
)
Balance as of September 30, 2015
 
25,592

 
$
26

 
$
146,988

 
$
(378
)
 
$
(68,289
)
 
$
(29,576
)
 
$
23,313

 
$
72,084


 
 
Common Stock
 
Additional Paid-In Capital
 
Treasury Stock
 
Accumulated Deficit
 
Accumulated Other Comprehensive Income (Loss)
 
Non- controlling Interest
 
 
 
 
Shares
 
Amount
 
 
 
 
 
 
Total
Balance as of December 31, 2015
 
35,250

 
$
35

 
$
209,477

 
$
(378
)
 
$
(79,729
)
 
$
(35,375
)
 
$
23,494

 
$
117,524

Share-based compensation expense
 
—

 
—

 
6,667

 
—

 
—

 
—

 
—

 
6,667

Fair value adjustment of Redeemable noncontrolling interest
 
—

 
—

 
(99
)
 
—

 
—

 
—

 
—

 
(99
)
Exercise of Warrants and Stock Options
 
2

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Shares withheld to satisfy tax withholdings
 
(201
)
 
—

 
—

 
(884
)
 
—

 
—

 
—

 
(884
)
Preferred stock dividend and accretion
 
—

 
—

 
(2,386
)
 
—

 
—

 
—

 
—

 
(2,386
)
Amortization of issuance costs and beneficial conversion feature
 
—

 
—

 
(309
)
 
—

 
—

 
—

 
—

 
(309
)
Issuance of common stock
 
65

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Issuance of restricted stock
 
199

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Conversion of Preferred Stock
 
2,564

 
3

 
10,850

 
—

 
—

 
—

 
—

 
10,853

Deemed dividend to induce conversion of Preferred Stock
 
152

 
—

 
(1,490
)
 
—

 
—

 
—

 
—

 
(1,490
)
Acquisition of controlling interests
 
—

 
—

 


 
—

 
—

 
—

 
2,161

 
2,161

Sale of controlling interest
 
—

 
—

 
—

 
—

 
—

 
—

 
8,000

 
8,000

Excess fair value over book value of noncontrolling interest sold
 
—

 
—

 
6,132

 
—

 
—

 
—

 
(6,132
)
 
—

Net loss
 
—

 
—

 
—

 
—

 
(33,085
)
 
—

 
(2,365
)
 
(35,450
)
Net income attributable to redeemable noncontrolling interest
 
—

 
—

 
—

 
—

 
—

 
—

 
1,228

 
1,228

Foreign currency translation adjustment
 
—

 
—

 
—

 
—

 
—

 
1,335

 
—

 
1,335

Unrealized gain on available-for-sale securities, net of tax
 
—

 
—

 
—

 
—

 
—

 
71,261

 
—

 
71,261

Balance as of September 30, 2016

38,031


$
38


$
228,842


$
(1,262
)

$
(112,814
)

$
37,221


$
26,386

 
$
178,411

See accompanying notes to Condensed Consolidated Financial Statements.

6

HC2 HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)


 
Nine Months Ended September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net loss
$
(35,450
)
 
$
(24,117
)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
 

 
 

Provision for doubtful accounts receivable
827

 
325

Share-based compensation expense
6,667

 
7,402

Depreciation and amortization
19,602

 
23,503

Amortization of deferred financing costs and debt discount
1,530

 
1,246

Amortization of fixed maturities discount/premium
8,966

 
—

(Gain) loss on sale or disposal of assets
251

 
(135
)
Net realized (gains) losses on investments
2,519

 
(431
)
Impairment of investments
4,321

 
—

Equity investment (income) loss
(3,153
)
 
(427
)
Lease termination costs
179

 
1,124

Deferred income taxes
(18,940
)
 
(5,957
)
Receipt of dividends from equity investees
7,214

 
2,448

Annuity benefits
6,737

 
—

All other operating activities
(224
)
 
315

Changes in assets and liabilities, net of acquisitions:
 

 
 

(Increase) decrease in accounts receivable
(56,463
)
 
(36,099
)
(Increase) decrease in costs and recognized earnings in excess of billings on uncompleted contracts
22,219

 
(9,253
)
(Increase) decrease in inventory
3,518

 
455

(Increase) decrease in other assets
26,725

 
(3,316
)
Increase (decrease) in life, accident and health reserves
41,942

 
—

Increase (decrease) in accounts payable, current and other liabilities
(12,625
)
 
42,364

Increase (decrease) in billings in excess of costs and recognized earnings on uncompleted contracts
30,040

 
(21,933
)
Increase (decrease) in pension liability
(1,423
)
 
(8,665
)
Net cash provided by (used in) operating activities
54,979

 
(31,151
)
Cash flows from investing activities:
 

 
 

Purchase of property, plant and equipment
(21,689
)
 
(16,751
)
Sale of property and equipment
511

 
4,994

Purchase of investments
(179,291
)
 
(41,710
)
Sale of investments
72,188

 
6,876

Sale of assets held for sale
5,900

 
1,479

Cash paid for business acquisitions, net of cash acquired
(10,871
)
 
(568
)
Maturities and redemptions of fixed maturity securities
53,663

 
—

Change in restricted cash
(253
)
 
(727
)
All other investing activities
(230
)
 
—

Net cash used in investing activities
(80,072
)
 
(46,407
)
Cash flows from financing activities:
 

 
 

Proceeds from long-term obligations
11,672

 
54,963

Principal payments on long-term obligations
(11,441
)
 
(8,473
)
Payment of deferred financing costs
—

 
(1,137
)
Annuity receipts
2,522

 
—

Annuity surrenders
(15,562
)
 
—


7


Proceeds from issuance of common stock of subsidiary
8,000

 
 
Proceeds from sale of preferred stock, net
—

 
14,033

Purchase of noncontrolling interest
(2,163
)
 
(239
)
Payment of withholdings related to net settlements
(884
)
 
—

Payment of dividends
(3,007
)
 
(3,855
)
Net cash provided by (used in) financing activities
(10,863
)
 
55,292

Effect of currency exchange rate changes on cash and cash equivalents
(1,347
)
 
(4,646
)
Net change in cash and cash equivalents
(37,303
)
 
(26,912
)
Cash and cash equivalents, beginning of period
158,624

 
107,978

Cash and cash equivalents, end of period
$
121,321

 
$
81,066

Supplemental cash flow information:
 

 
 

Cash paid for interest
$
21,491

 
$
21,445

Cash paid for taxes
$
13,469

 
$
1,701

Non-cash investing and financing activities:
 

 
 

Purchases of property, plant and equipment under financing arrangements
$
—

 
$
1,808

Property, plant and equipment included in accounts payable
$
1,542

 
$
1,521

Fair value of contingent asset assumed in other acquisitions
$
2,992

 
$
—

Fair value of deferred liability assumed in other acquisitions
$
2,589

 
$
—

Debt assumed in other acquisitions
$
20,813

 
$
—

Deemed dividend from conversion of preferred stock
$
1,490

 
$
—

Conversion of preferred stock
$
10,853

 
$
1,000


See accompanying notes to Condensed Consolidated Financial Statements.


8
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1. Organization and Business

HC2 Holdings, Inc. (“HC2” and, together with its subsidiaries, the “Company”, “we”, "us" and “our”) is a diversified holding company which seeks to acquire and grow attractive businesses that the Company believes can generate long-term sustainable free cash flow and attractive returns. While the Company generally intends to acquire controlling equity interests in its operating subsidiaries, the Company also invests to a more limited extent in a variety of debt instruments or noncontrolling equity interest positions. HC2's common stock trades on the NYSE MKT LLC under the symbol “HCHC”.

The Company currently has seven reportable segments based on management’s organization of the enterprise - Manufacturing, Marine Services, Insurance, Utilities, Telecommunications, Life Sciences, and Other which includes operations that do not meet the separately reportable segment thresholds.

1.Our Manufacturing segment includes DBM Global Inc. (“DBM Global”, f/k/a Schuff International, Inc.) and its wholly-owned subsidiaries. DBM Global offers integrated steel construction services from a single source and professional services that include design-assist, design-build, engineering, building information modeling participation, 3D steel modeling / detailing, fabrication, advanced field erection, project management and state-of-the-art steel management systems. Major market segments for DBM Global include commercial, healthcare, convention centers, stadiums, gaming and hospitality, mixed use and retail, industrial, public works, bridges, transportation, and international projects. Headquartered in Phoenix, Arizona, DBM Global has operations in Arizona, California, Georgia, Kansas, and Texas, with construction projects primarily located in the aforementioned states, in addition to international construction projects in select markets, primarily Panama, through its Panamanian joint venture Schuff Hopsa Engineering. The Company maintains a 92% controlling interest in DBM Global.

2.Our Marine Services segment includes Global Marine Systems Limited ("GMSL"). GMSL is a leading provider of engineering and underwater services on submarine cables. The Company maintains a 95% equity interest in GMSL.

3.Our Insurance segment includes United Teacher Associates Insurance Company ("UTA") and Continental General Insurance Company ("CGI", and together with UTA, the "Insurance Companies"). The Insurance Companies provide long-term care, life and annuity coverage that help protect policy and certificate holders from the financial hardships associated with illness, injury, loss of life, or income continuation. The Company owns 100% of the Insurance Companies.

4.Our Utilities segment includes American Natural Gas ("ANG"). Headquartered in the Northeast, ANG is a premier distributor of natural gas motor fuel. ANG designs, builds, owns, acquires, operates and maintains compressed natural gas fueling stations for transportation vehicles. The Company maintains effective control of, and a 49.99% ownership interest in ANG.

5.Our Telecommunications segment includes PTGi International Carrier Services, ("ICS"). ICS operates a telecommunications business including a network of direct routes and provides premium voice communication services for national telecom operators, mobile operators, wholesale carriers, prepaid operators, Voice over Internet Protocol ("VOIP") service operators and Internet service providers from our International Carrier Services business unit. ICS provides a quality service via direct routes and by forming strong relationships with carefully selected partners. The Company owns 100% of ICS.

6.Our Life Sciences segment includes Pansend Life Sciences, LLC (“Pansend”). Pansend owns a (i) 77% interest in Genovel Orthopedics, Inc., which seeks to develop products to treat early osteoarthritis of the knee, (ii) 61% interest in R2 Dermatology Incorporated (f/k/a GemDerm Aesthetics, Inc.), which develops skin lightening technology, and (iii) 80% interest in BeneVir Biopharm, Inc. ("BeneVir"), which focuses on immunotherapy for the treatment of solid tumors. Pansend also invests in other early stage or developmental stage healthcare companies.

7.In our Other segment, we invest in and grow developmental stage companies that we believe have significant growth potential. Among the businesses included in this segment are the Company's 56% ownership interest in DMi, Inc. ("DMi"), which owns licenses to create and distribute NASCAR® video games, and the Company's 72% interest in NerVve Technologies Inc. ("NerVve"), which provides analytics on broadcast TV, digital and social media online platforms.







9
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial reporting and Securities and Exchange Commission (“SEC”) regulations. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such principles and regulations. In the opinion of management, the financial statements reflect all adjustments (all of which are of a normal and recurring nature), which are necessary to present fairly the financial position, results of operations, cash flows and comprehensive income (loss) for the interim periods. The results for the Company’s nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2016. The financial statements should be read in conjunction with the Company’s audited consolidated financial statements included in the Company’s most recently filed Annual Report on Form 10-K.

Principles of Consolidation

The Condensed Consolidated Financial Statements include the accounts of the Company, its wholly owned subsidiaries and all other subsidiaries over which the Company exerts control. All intercompany profits, transactions and balances have been eliminated in consolidation. As of September 30, 2016, the Company has a 100% interest in the Insurance Companies, a 100% interest in ICS, a 95% interest in GMSL, a 92% interest in DBM Global, a 56% interest in DMi, a 72% interest in NerVve, and board control of, and a 49.99% interest in ANG. Because the Company controls the operations of ANG through its control of the board, the assets, liabilities, revenues and expenses of ANG are included in our Condensed Consolidated Financial Statements. Through its subsidiary, Pansend, the Company has a 77% interest in Genovel Orthopedics, Inc., a 61% interest in R2 Dermatology and an 80% interest in BeneVir. The results of each of these entities are consolidated with the Company’s results from and after their respective acquisition dates based on guidance from the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation” (“ASC 810”). The remaining interests not owned by the Company are presented as a noncontrolling interest component of total equity. DBM Global uses a 4-4-5 week quarterly cycle, which for the third quarter of 2016 ended on October 1, 2016.

Reclassification

Certain previous year amounts have been reclassified to conform with current year presentations related to the reporting of new financial statement line items.

Adjustments

During the second quarter of 2016, the Company identified an immaterial error in its calculation of depreciation expense for the twelve months ended December 31, 2015 and 2014 and the three months ended March 31, 2016 related to purchase accounting associated with the acquisition of DBM Global in May of 2014.  This resulted in an excess depreciation expense being recorded in each of the periods noted.  In addition, certain gains and losses on assets that were disposed of by DBM Global were incorrectly recorded during the same periods as a result of these adjustments.  The net impact of these adjustments to net income would have been an increase of $0.7 million and a decrease of $0.2 million for the twelve months ended December 31, 2015 and 2014, respectively, and an increase of $0.8 million for the three months ended March 31, 2016. 

The Company determined to correct the cumulative effect of these adjustments in the second quarter of 2016, which resulted in a net adjustment to net income (loss) attributable to common and participating preferred stockholders for the nine months ended September 30, 2016 of $1.3 million.  Excluding this adjustment, net loss attributable to common and participating preferred stockholders would have been $39.4 million or $1.10 per fully diluted share for the nine months ended September 30, 2016, instead of the $38.1 million recorded.

Newly Adopted Accounting Principles

In September 2015, the FASB issued Accounting Standards Update ("ASU") 2015-16, “Business Combination Topic No. 805: Simplifying the Accounting for Measurement - Period Adjustments”, which requires adjustments to provisional amounts that are identified during the measurement period to be recognized in the reporting period in which the adjustment amounts are determined.

10
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

This includes any effect on earnings of changes in depreciation, amortization, or other income effects as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.

In August 2015, the FASB issued ASU 2015-15, “Interest - Imputation of Interest Subtopic No. 835-30: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements,” which codifies an SEC staff announcement that entities are permitted to defer and present debt issuance costs related to line-of-credit arrangements as assets, rather than as a direct offset to the liability as is required now under ASU 2015-03. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.

In July 2015, the FASB issued ASU 2015-12, "(Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, and (Part III) Measurement Date Practical Expedient". Part I of this ASU is related to one area of several potential simplifications for employee benefit plans and designates contract value as the only required measure for fully benefit-responsive investment contracts, which maintains the relevant information while reducing the cost and complexity of reporting for fully benefit responsive investment contracts. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.

In May 2015, the FASB has issued ASU 2015-9, "Disclosures About Short-Duration Contracts". This ASU requires insurance entities to disclose for annual reporting periods certain information in respect of liability for unpaid claims and claim adjustment expenses. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.

In May 2015, the FASB issued ASU 2015-8, “Business Combinations Topic No. 805: Pushdown Accounting-Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115 (SEC Update),” which rescinds certain SEC guidance in order to conform with ASU 2014-17, “Pushdown Accounting” (“ASU 2014-17”). ASU 2014-17 was issued in November 2014 and provides a reporting entity that is a business or nonprofit activity (an “acquiree”) the option to apply pushdown accounting to its separate financial statements when an acquirer obtains control of the acquiree. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.

In May 2015, the FASB issued ASU 2015-07, "Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)". The amendments in this ASU remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.

In February 2015, the FASB issued ASU 2015-2, “Amendments to the Consolidation Analysis”, which amends the consolidation requirements in ASC 810 and significantly changes the consolidation analysis required under U.S. GAAP relating to whether or not to consolidate certain legal entities. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.

In January 2015, the FASB issued ASU 2015-1, “Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items”, which eliminates from U.S. GAAP the concept of an extraordinary item. Under the ASU, an entity will no longer (1) segregate an extraordinary item from the results of ordinary operations; (2) separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; or (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. On January 1, 2016, the Company adopted this update, which did not have a material impact on the Condensed Consolidated Financial Statements.

New Accounting Pronouncements

In August, 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force)" ("ASU 2016-15"). The amendments in ASU 2016-15 address eight specific cash flow issues and apply to all entities that are required to present a statement of cash flows under FASB ASC 230, "Statement of Cash Flows." The amendments in ASU 2016-15 are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption during an interim period. The Company

11
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

has not yet adopted this update and is currently evaluating the impact of ASU 2016-15 on its Condensed Consolidated Financial Statements.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses" (Topic 326)" ("ASU-2016-13"), which amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, ASU 2016-13 eliminates the probable initial recognition threshold in current U.S. GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. For available-for-sale debt securities, credit losses should be measured in a manner similar to current U.S. GAAP, however ASU 2016-13 will require that credit losses be presented as an allowance rather than as a write-down. For public business entities that file reports with the SEC, the amendments in the ASU are effective for fiscal years beginning after December 15, 2019. The Company has not yet adopted this update and is currently evaluating the impact of ASU 2016-13 on its Condensed Consolidated Financial Statements.

In May 2016, the FASB issued ASU 2016-12, "Revenue From Contracts With Customers" "(Topic 606)" ("ASU 2016-12"), which addresses narrow-scope improvements to the guidance on collectability, non-cash consideration, and completed contracts at transition. Additionally, the amendments in this update provide a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. The effective date and transition requirements for the amendments in this update are the same as the effective date and transition requirements for ASU 2016-12 (and any other Topic amended by ASU 2014-09). "Revenue from Contracts with Customers (Topic 606), Section A - Summary and Amendments that Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs - Contracts with Customers (Subtopic 340-40)" ("ASU 2014-09"). ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, defers the effective date of Update 2014-09 by one year. The Company has not yet adopted this update and is currently evaluating the impact of ASU 2016-12 on its Condensed Consolidated Financial Statements.

In April 2016, the FASB issued ASU 2016-10, "Revenue From Contracts With Customers (Topic 606): Identifying Performance Obligations and Licensing" ("ASU 2016-10"), which clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in the new revenue recognition standard. Further, this update includes targeted improvements based on input the Board received from the Transition Resource Group for Revenue Recognition and other stakeholders. ASU 2016-10seeks to proactively address areas in which diversity in practice potentially could arise, as well as to reduce the cost and complexity of applying certain aspects of the guidance both at implementation and on an ongoing basis. The Company has not yet adopted ASU 2016-10 and is currently evaluating the impact the update would have on its Condensed Consolidated Financial Statements.

In March 2016, the FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting" "(Topic 718)" ("ASU 2016-09"), which introduces targeted amendments intended to simplify accounting for stock compensation. Specifically, ASU 2016-09 requires all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) to be recognized as income tax expense or benefit in the income statement. Early adoption is permitted. The Company has not yet adopted this update and is currently evaluating the update would have on its Condensed Consolidated Financial Statements.

In March 2016, the FASB issued ASU 2016-08, "Principal versus Agent Considerations" (Topic 606), which updates the new revenue standard by clarifying the principal versus agent implementation guidance. Early adoption is permitted. The Company's effective date for adoption is January 1, 2018. The Company has not yet adopted this update and is currently evaluating the impact of ASU 2016-08 on its Condensed Consolidated Financial Statements.

In March 2016, the FASB issued ASU 2016-07, "Simplifying the Transition to the Equity Method of Accounting" "(Topic 323)" ("ASU 2016-07"), which requires an investor to initially apply the equity method of accounting from the date such investor qualifies for that method (i.e., the date such investor obtains significant influence over the operating and financial policies of an investee). The ASU eliminates the previous requirement to retroactively adjust the investment and record a cumulative catch up for the periods that the investment had been held, but did not qualify for the equity method of accounting. Early adoption is permitted. The Company's effective date for adoption is January 1, 2017. The Company has not yet adopted this update and is currently evaluating the impact of ASU 2016-07 on its Condensed Consolidated Financial Statements.


12
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

In March 2016, the FASB issued ASU 2016-06, "Contingent Put and Call Options in Debt Instruments" "(Topic 815)" ("ASU 2016-06"), which addresses how an entity should assess whether contingent call or put options that can accelerate the payment of debt instruments are clearly and closely related to their debt hosts. This assessment is necessary to determine if the option(s) must be separately accounted for as a derivative. ASU 2016-06 clarifies that an entity is required to assess the embedded call or put options in accordance with a specific four-step decision sequence. This means that entities are not also required to assess whether the contingency for exercising the option(s) is indexed to interest rates or credit risk. For example, when evaluating debt instruments that may be put upon a change in control, the event triggering the change in control is not relevant to the assessment. Only the resulting settlement of debt is subject to the four-step decision sequence. Early adoption is permitted. The Company's effective date for adoption is January 1, 2017. The Company has not yet adopted ASU 2016-06 and is currently evaluating the impact the update would have on its Condensed Consolidated Financial Statements.

In February 2016, the FASB issued ASU 2016-02, "Leases" "(Topic 842)" ("ASU 2016-02"), which applies a right-of-use (ROU) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. ASU 2016-02 requires a lessor to classify leases as either sales-type, direct financing or operating, similar to existing U.S. GAAP requirements. Classification depends on the same five criteria used by lessees as well as certain additional factors. The new standard addresses other considerations including identification of a lease, separating lease and nonlease components of a contract, sale and leaseback transactions, modifications, combining contracts, reassessment of the lease term, and remeasurement of lease payments. Early adoption is permitted. The Company’s effective date for adoption is January 1, 2019. The Company has not yet adopted ASU 2016-02 and is currently evaluating the impact the update would have on its Condensed Consolidated Financial Statements.

In January 2016, the FASB issued ASU 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities" "(Subtopic 825-10)" ("ASU 2016-01") which, among other things, requires all equity securities currently classified as “available for sale” to be reported at fair value, with holding gains and losses recognized in net income instead of accumulated other comprehensive income ("AOCI"). Certain provisions of ASU 2016-01 are eligible for early adoption. The Company’s effective date for adoption is January 1, 2018. The Company has not yet adopted ASU 2016-01 and is currently evaluating the impact the update would have on its Condensed Consolidated Financial Statements. 

3. Business Combinations

The Company’s acquisitions were accounted for using the acquisition method of accounting, which requires, among other things, that assets acquired and liabilities assumed be recognized at their estimated fair values as of the acquisition date. Estimates of fair value included in the Condensed Consolidated Financial Statements, in conformity with ASC 820, “Fair Value Measurements and Disclosures”, represent the Company’s best estimates and valuations developed, when needed, with the assistance of independent appraisers or, where such valuations have not yet been completed or are not available, industry data and trends and by reference to relevant market rates and transactions. The following estimates and assumptions are inherently subject to significant uncertainties and contingencies beyond the control of the Company. Accordingly, the Company cannot provide assurance that the estimates, assumptions, and values reflected in the valuations will be realized, and actual results could vary materially.

Any changes to the initial estimates of the fair value of the assets and liabilities will be recorded as adjustments to those assets and liabilities, and residual amounts will be allocated to goodwill. In accordance with ASC 805 “Business Combinations,” if additional information is obtained about the initial estimates of the fair value of the assets acquired and liabilities assumed within the measurement period (not to exceed one year from the date of acquisition), including finalization of asset appraisals, the Company will refine its estimates of fair value to allocate the purchase price more accurately.

Insurance Segment

On December 24, 2015, the Company completed the acquisitions of 100% of the interest in each of the Insurance Companies as well as all assets owned by the sellers of the Insurance Companies and their affiliates (the "Seller Parties") that are used exclusively or primarily in the business of the Insurance Companies, subject to certain exceptions. The operations of the Insurance Companies form the basis of our Insurance segment, and we plan to leverage their existing platform and industry expertise to identify strategic growth opportunities for managing closed blocks of long-term care businesses.


13
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The aggregate consideration paid in connection with the acquisition of the Insurance Companies and related transactions and agreements was valued at $18.7 million, consisting of $7.1 million of cash, $2.0 million in aggregate principal amount of the Company’s 11.0% Senior Secured Notes due 2019, 1,007,422 shares of the Company's common stock and five-year warrants to purchase 2,000,000 shares of the Company's common stock at an exercise price of $7.08 per share (subject to customary adjustments for stock splits or similar transactions) exercisable on or after February 3, 2016 (the "Warrants").

Purchase Price Allocation

The preliminary fair values of identified assets acquired, liabilities assumed, residual goodwill and consideration transferred are summarized as follows (in thousands):
Fair value of consideration transferred
 
 
Cash
 
$
7,146

Company’s Senior Secured Notes
 
1,879

Company's common stock
 
5,380

2016 Warrants
 
4,332

Total fair value of consideration transferred
 
$
18,737

 
 
 
Purchase price allocation
 
 
Fixed maturities, available for sale at fair value
 
$
1,230,038

Equity securities, available for sale at fair value
 
35,697

Mortgage loans
 
1,252

Policy loans
 
18,354

Other investments
 
183

Cash and cash equivalents
 
48,525

Recoverable from reinsurers
 
522,790

Accrued investment income
 
14,417

Goodwill
 
46,613

Intangibles
 
4,850

Other assets
 
12,869

Total assets acquired
 
1,935,588

Life, accident and health reserves
 
(1,592,722
)
Annuity reserves
 
(259,675
)
Value of business acquired
 
(51,584
)
Deferred tax liability
 
(1,704
)
Other liabilities
 
(11,166
)
Total liabilities assumed
 
(1,916,851
)
Total net assets acquired
 
$
18,737


The values of intangibles, life, accident and health reserves, annuity reserves, and value of business acquired are estimates and might change.

The acquisition of the Insurance Companies resulted in the recording of goodwill of approximately $46.6 million. Goodwill consists of the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. The Insurance Companies were recognized as a new stand-alone reporting unit. Goodwill is not amortized and is not deductible for tax purposes.

The Value of Business Acquired ("VOBA")

The VOBA was derived using a “Becker-ized” Present Value of Distributable Earnings (“PVDE”) method. The PVDE was derived using the statutory after tax profits. The VOBA was valued at $51.6 million and is amortized over the anticipated remaining

14
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

future lifetime of the acquired long-term care blocks of business.  VOBA is amortized in relation to the projected future premium of the acquired long-term care blocks of business.

Recoverable from Reinsurers

The recoverable from reinsurers balance represents amounts recoverable from third parties. U.S. GAAP requires insurance reserves and recoverable from reinsurers balances to be presented on a gross basis, as opposed to U.S. statutory accounting principles, where reserves are presented net of reinsurance. Accordingly, the Company grossed up the fair value of the net insurance contract liability for the amount of reinsurance of approximately $515.9 million, to arrive at a gross insurance liability, and recognized an offsetting recoverable from reinsurers amount of approximately $515.9 million. As part of this process, management analyzed reinsurance counterparty credit risk and considers it to have an immaterial impact on the reinsurance fair value gross-up. To mitigate this risk substantially all reinsurance is ceded to companies with investment grade S&P ratings.
    
Amounts recoverable from reinsurers were estimated in a manner consistent with the liability associated with the reinsured policies and were an estimate of the recoverable from reinsurers amount in respect of each of paid and unpaid losses, including an estimate for losses incurred but not reported. Recoverable from reinsurers represents expected cash inflows from reinsurers for liabilities ceded and therefore incorporate uncertainties as to the timing and amount of claim payments. Recoverable from reinsurers includes the balances due from reinsurers under the terms of the reinsurance agreements for these ceded balances as well as settlement amounts currently due.

Contingent Liability

Pursuant to the agreements governing the acquisition of the Insurance Companies, the Company also agreed to pay to the Seller Parties, on an annual basis with respect to the years 2015 through 2019, the amount, if any, by which the Insurance Companies’ cash flow testing and premium deficiency reserves decrease from the amount of such reserves as of December 31, 2014. Such payments are capped at $13.0 million in the aggregate. The balance is calculated based on the fluctuation of the statutory cash flow testing and premium deficiency reserves annually following each of the Insurance Companies' filing with its applicable insurance regulator of its annual statutory financial statements for each calendar year ending December 31 through and including December 31, 2019. Based on the 2015 statutory statements, the Company does not have a payment due. Further, the Company's current estimate is that the obligation will not be incurred through the calendar year ending December 31, 2019. This expectation is primarily driven by the following factors: (i) reduced confidence that treasury rates will increase to historical averages over the near term; (ii) uncertainty around future operating expenses historically performed by the Seller Parties; and (iii) the increase in the premium deficiency reserve as reported at December 31, 2015 of approximately $8.0 million (because the balance is cumulative over the period, a decrease of approximately $8.0 million would be required before there would be any obligation to the Seller Parties under the earn-out). The Company will perform this assessment at each reporting period through December 31, 2019 or until the $13.0 million is paid in full.

Control Level Risk-Based Capital

In connection with the consummation of the acquisition of the Insurance Companies, the Company agreed with the statutory regulator of CGI, the Ohio Department of Insurance ("ODOI"), that for five years following the closing of the transaction, the Company will contribute to CGI cash or marketable securities acceptable to the ODOI to the extent required for CGI’s total adjusted capital to be not less than 400% of CGI’s authorized control level risk-based capital (each as defined under Ohio law and reported in CGI’s statutory statements filed with the ODOI). Similarly, the Company has agreed with the statutory regulator of UTA, the Texas Department of Insurance ("TDOI"), that, for five years following the closing of the transaction, the Company will contribute to UTA cash or other admitted assets acceptable to the TDOI to the extent required for UTA’s total adjusted capital to be not less than 400% of UTA’s authorized control level risk-based capital (each as defined under Texas law and reported in UTA’s statutory statements filed with the TDOI).

In connection with the consummation of the acquisition of the Insurance Companies, each of the Insurance Companies also entered into a capital maintenance agreement with Great American Financial Resources, Inc. ("GAFRI" and each such agreement, a “Capital Maintenance Agreement,” and collectively, the “Capital Maintenance Agreements”). Under each Capital Maintenance Agreement, if the applicable Insurance Company's total adjusted capital reported in its annual statutory financial statements is less than 400% of its authorized control level risk-based capital, GAFRI will pay cash or assets to the applicable Insurance Company, as required, to eliminate such shortfall (after giving effect to any capital contributions made by the Company or its affiliates since the date of the relevant annual statutory financial statements). GAFRI’s obligation to make such payments is capped at $25.0

15
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

million under the Capital Maintenance Agreement with UTA and $10.0 million under the Capital Maintenance Agreement with CGI. Each of the Capital Maintenance Agreements will remain in effect from January 1, 2016 to January 1, 2021, or until payments by GAFRI thereunder equal the maximum amount payable under the applicable agreement. The Company will indemnify GAFRI for the amount of any payments made by it under the Capital Maintenance Agreements.

Other

Transaction costs incurred in connection with the acquisition of the Insurance Companies were $0.0 and $0.5 million during the three and nine months ended September 30, 2016 and were included within Selling, general and administrative expenses. The Company recorded net revenue of $34.5 million and $99.8 million and net loss of $2.0 million and $12.6 million from the Insurance Companies for the three and nine months ended September 30, 2016.

Pro Forma Adjusted Summary

The results of operations for the Insurance Companies have been included in the Condensed Consolidated Financial Statements subsequent to their acquisition date.

The following schedule presents unaudited consolidated pro forma results of operations data as if the acquisition of the Insurance Companies had occurred on January 1, 2015. This information neither purports to be indicative of the actual results that would have occurred if those acquisitions had actually been completed on the date indicated, nor is it necessarily indicative of the future operating results or the financial position of the combined company (in thousands, except per share amounts): 
 
 
Three Months Ended
September 30, 2015


Nine Months Ended
September 30, 2015

Net revenue
 
$
315,371

 
$
876,697

Net loss from continuing operations
 
$
(7,119
)
 
$
(22,451
)
Loss from discontinued operations
 
(24
)
 
(44
)
Net loss attributable to HC2
 
$
(7,143
)
 
$
(22,495
)
 
 
 
 
 
Per share amounts:
 
 
 
 
Loss from continuing operations
 
$
(0.28
)
 
$
(0.89
)
Loss from discontinued operations
 
$
—

 
$
—

Net loss attributable to HC2
 
$
(0.28
)
 
$
(0.90
)

Other Acquisitions

During the nine months ended September 30, 2016, we purchased three fueling stations, completed the acquisition of additional interests in and thereby control of NerVve and BeneVir, and acquired a 60% controlling interest in CWind Limited ("CWind") with an obligation to purchase the remaining 40% in equal amounts on September 30, 2016 and September 30, 2017 (based on agreed financial targets). The total consideration transferred for these acquisitions was $21.9 million including $13.7 million in cash. The results of each of the companies acquired have been reported in our results of operations from the date of acquisition.

We have preliminarily allocated the purchase price of these acquired businesses to tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. We are in the process of completing the valuation of identifiable intangible assets, fixed assets and debt; therefore, the fair values set forth below are subject to adjustment upon finalization of the valuations. The amounts in respect of these potential adjustments could be significant. We expect to complete the purchase price allocation for fiscal year 2016 acquisitions during fiscal year 2017.

The following table summarizes the preliminary allocation of the purchase price to the fair value of identifiable assets acquired and liabilities assumed for the fiscal year 2016 acquisitions at the date of acquisition, in accordance with the acquisition method of accounting:





16
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
 
Total
Consideration
 
 
Cash
 
$
13,671

Convertible notes
 
2,915

Promissory note
 
1,128

Fair value of previously held interest
 
4,610

Contingent asset
 
(2,992
)
Deferred consideration
 
2,589

Total fair value of consideration transferred
 
$
21,921

 
 
 
Purchase price allocation
 
 
Cash and cash equivalents
 
$
2,966

Accounts receivable
 
6,400

Inventory
 
528

Property, plant and equipment, net
 
32,439

Goodwill
 
7,242

Intangibles
 
12,557

Other assets
 
2,335

Total assets acquired
 
64,467

Accounts payable and other current liabilities
 
(11,180
)
Deferred tax liability
 
(5,494
)
Long-term obligations
 
(20,813
)
Other liabilities
 
(15
)
Noncontrolling interest
 
(815
)
Total liabilities assumed
 
(38,317
)
Enterprise value
 
26,150

Less fair value of noncontrolling interest
 
3,889

Bargain purchase gain
 
340

Purchase price attributable to controlling interest
 
$
21,921


4. Investments

Fixed Maturity and Equity Securities Available-for-Sale

The following tables provide information relating to investments in fixed maturity and equity securities as of September 30, 2016 and December 31, 2015 (in thousands):
September 30, 2016
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
16,081

 
$
834

 
$
—

 
$
16,915

States, municipalities and political subdivisions
 
375,661

 
25,988

 
(36
)
 
401,613

Foreign government
 
6,392

 
—

 
(113
)
 
6,279

Residential mortgage-backed securities
 
141,837

 
2,192

 
(550
)
 
143,479

Commercial mortgage-backed securities
 
59,114

 
1,113

 
(78
)
 
60,149

Asset-backed securities
 
68,865

 
1,912

 
(261
)
 
70,516

Corporate and other
 
587,499

 
48,194

 
(2,967
)
 
632,726

Total fixed maturity securities
 
$
1,255,449

 
$
80,233

 
$
(4,005
)
 
$
1,331,677

Equity securities
 
 
 
 
 
 
 
 
Common stocks
 
$
17,485

 
$
2,402

 
$
(393
)
 
$
19,494

Perpetual preferred stocks
 
36,752

 
734

 
(474
)
 
37,012

Total equity securities
 
$
54,237

 
$
3,136

 
$
(867
)
 
$
56,506


17
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

December 31, 2015
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
Fixed maturity securities
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
17,131

 
$
1

 
$
(49
)
 
$
17,083

States, municipalities and political subdivisions
 
387,427

 
60

 
(1,227
)
 
386,260

Foreign government
 
6,426

 
3

 
—

 
6,429

Residential mortgage-backed securities
 
166,324

 
579

 
(588
)
 
166,315

Commercial mortgage-backed securities
 
74,898

 
233

 
(96
)
 
75,035

Asset-backed securities
 
34,396

 
106

 
(51
)
 
34,451

Corporate and other
 
553,487

 
318

 
(7,537
)
 
546,268

Total fixed maturity securities
 
$
1,240,089

 
$
1,300

 
$
(9,548
)
 
$
1,231,841

Equity securities
 
 
 
 
 
 
 
 
Common stocks
 
$
19,935

 
$
1

 
$
(1,311
)
 
$
18,625

Perpetual preferred stocks
 
30,901

 
162

 
(6
)
 
31,057

Total equity securities
 
$
50,836

 
$
163

 
$
(1,317
)
 
$
49,682


The Company has investments in mortgage-backed securities ("MBS") that contain embedded derivatives (primarily interest-only MBS) that do not qualify for hedge accounting. The Company recorded the change in the fair value of these securities within Net realized losses on investments. These investments had a fair value of $15.0 million and $21.0 million as of September 30, 2016 and December 31, 2015, respectively. The change in fair value related to these securities resulted in a net loss of approximately $0.1 million and $2.4 million for the three and nine months ended September 30, 2016, respectively, and $0 for each of the three and nine months ended September 30, 2015.

Maturities of Fixed Maturity Securities Available-for-Sale

The amortized cost and fair value of fixed maturity securities available-for-sale as of September 30, 2016 are shown by contractual maturity in the table below (in thousands). Actual maturities can differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset and mortgage-backed securities are shown separately in the table below, as they are not due at a single maturity date:
 
 
Amortized
 
Fair
 
 
Cost
 
Value
Corporate, Municipal, U.S. Government and Other securities
 
 
 
 
Due in one year or less
 
$
40,777

 
$
38,312

Due after one year through five years
 
115,932

 
120,562

Due after five years through ten years
 
141,642

 
148,033

Due after ten years
 
687,282

 
750,626

Subtotal
 
985,633

 
1,057,533

Mortgage-backed securities
 
200,951

 
203,628

Asset-backed securities
 
68,865

 
70,516

Total
 
$
1,255,449

 
$
1,331,677


Corporate Fixed Maturity Securities

The tables below show the major industry types of the Company’s corporate and other fixed maturity securities as of September 30, 2016 and December 31, 2015 (in thousands):







18
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
 
September 30, 2016
 
December 31, 2015
 
 
Amortized
 
Fair
 
% of
 
Amortized
 
Fair
 
% of
 
 
Cost
 
Value
 
Total
 
Cost
 
Value
 
Total
Finance, insurance, and real estate
 
$
210,441

 
$
216,550

 
34.2
%
 
$
223,144

 
$
217,377

 
39.8
%
Transportation, communication and other services
 
166,645

 
181,405

 
28.7
%
 
156,022

 
155,175

 
28.4
%
Manufacturing
 
118,492

 
129,738

 
20.5
%
 
95,138

 
94,792

 
17.4
%
Other
 
91,921

 
105,033

 
16.6
%
 
79,183

 
78,924

 
14.4
%
Total
 
$
587,499

 
$
632,726

 
100.0
%
 
$
553,487

 
$
546,268

 
100.0
%

Other-Than-Temporary Impairments - Fixed Maturity and Equity Securities

A portion of certain other-than-temporary impairment (“OTTI”) losses on fixed maturity securities is recognized in AOCI. For these securities the net amount recognized in the Condensed Consolidated Statements of Operations (“credit loss impairments”) represents the difference between the amortized cost of the securities and the net present value of their projected future cash flows discounted at the effective interest rate implicit in such securities prior to impairment. Any remaining difference between the fair value and amortized cost is recognized in AOCI. The Company recorded a $1.5 million and $2.6 million impairment related to two fixed maturity securities for the three and nine months ended September 30, 2016, respectively. The Company reported a $2.5 million impairment within Other income (expense), net and a $0.2 million impairment within Net realized losses on investments. The Company did not record any impairments on fixed maturity or equity securities during the three and nine months ended September 30, 2015.

Unrealized Losses for Fixed Maturity and Equity Securities Available-for-Sale

The following table presents the total unrealized losses for the 117 and 528 fixed maturity and equity securities held by the Company as of September 30, 2016 and December 31, 2015, respectively, where the estimated fair value had declined and remained below amortized cost by the indicated amount (in thousands):
 
 
September 30, 2016
 
December 31, 2015
 
 
Unrealized
 
% of
 
Unrealized
 
% of
 
 
Losses
 
Total
 
Losses
 
Total
Fixed maturity and equity securities
 
 
 
 
 
 
 
 
Less than 20%
 
$
(1,965
)
 
40.3
%
 
$
(5,667
)
 
52.2
%
20% or more for less than six months
 
(337
)
 
6.9
%
 
—

 
—
%
20% or more for six months or greater
 
(2,570
)
 
52.8
%
 
(5,198
)
 
47.8
%
Total
 
$
(4,872
)
 
100.0
%
 
$
(10,865
)
 
100.0
%

The determination of whether unrealized losses are “other-than-temporary” requires judgment based on subjective as well as objective factors. Factors considered and resources used by management include (i) whether the unrealized loss is credit-driven or a result of changes in market interest rates, (ii) the extent to which fair value is less than cost basis, (iii) cash flow projections received from independent sources, (iv) historical operating, balance sheet and cash flow data contained in issuer SEC filings and news releases, (v) near-term prospects for improvement in the issuer and/or its industry, (vi) third party research and communications with industry specialists, (vii) financial models and forecasts, (viii) the continuity of dividend payments, maintenance of investment grade ratings and hybrid nature of certain investments, (ix) discussions with issuer management, and (x) ability and intent to hold the investment for a period of time sufficient to allow for anticipated recovery in fair value.

The Company analyzes its MBS for other-than-temporary impairment each quarter based upon expected future cash flows. Management estimates expected future cash flows based upon its knowledge of the MBS market, cash flow projections (which reflect loan-to-collateral values, subordination, vintage and geographic concentration) received from independent sources, implied cash flows inherent in security ratings and analysis of historical payment data.

The Company believes it will recover its cost basis in the non-impaired securities with unrealized losses and that the Company has the ability to hold the securities until they recover in value. The Company neither intends to sell nor does it expect to be required to sell the securities with unrealized losses as of September 30, 2016 and December 31, 2015, respectively. However, unforeseen

19
HC2 HOLDINGS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

facts and circumstances may cause the Company to sell fixed maturity and equity securities in the ordinary course of managing its portfolio to meet certain diversification, credit quality and liquidity guidelines.

The following tables present the estimated fair values and gross unrealized losses for the 117 and 528 fixed maturity and equity securities held by the Company that have estimated fair values below amortized cost as of September 30, 2016 and December 31, 2015, respectively. The Company does not have any OTTI losses reported in AOCI. These investments are presented by investment category and the length of time the related fair value has remained below amortized cost (in thousands):
September 30, 2016
 
Less than 12 months
 
12 months of greater
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
Fixed maturity securities
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government and government agencies
 
$
131

 
$
—

 
$
—

 
$
—

 
$
131

 
$
—

States, municipalities and political subdivisions
 
7,080

 
(36
)
 
—

 
—

 
7,080

 
(36
)
Foreign government
 
6,279

 
(113
)
 
—

 
—

 
6,279

 
(113
)
Residential mortgage-backed securities
 
47,909

 
(550
)
 
—

 
—

 
47,909

 
(550
)
Commercial mortgage-backed securities
 
10,703

 
(78
)
 
—

 
—

 
10,703

 
(78
)
Asset-backed securities
 
17,939

 
(261
)
 
—

 
—

 
17,939

 
(261
)
Corporate and other
 
40,389

 
(396
)
 
5,040

 
(2,571
)
 
45,429

 
(2,967
)
Total fixed maturity securities
 
$
130,430

 
$
(1,434
)
 
$
5,040

 
$
(2,571
)
 
$
135,470

 
$
(4,005
)
Equity securities
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
 
$
5,515

 
$
(393
)
 
$
—

 
$
—

 
$
5,515

 
$
(393
)
Perpetual preferred stocks
 
11,520

 
(474
)
 
—

 
—

 
11,520

 
(474
)
Total equity securities
 
$
17,035

 
$
(867
)
 
$
—

 
$
—

 
$
17,035

 
$
(867
)
December 31, 2015
 
Less than 12 months
 
12 months of greater
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses